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Pricing Abuses by Essential Patent Holders in a Standard-Setting Context: A View from Europe

George Mason University School of Law; Tilburg University - Tilburg Law and Economics Center (TILEC)

July 2008

Abstract:

Intellectual property rights (hereafter, "IPR") are legitimate exclusive rights, which confer upon their owners two basic prerogatives: the right to prevent any third party from applying or using the subject-matter of the IPR and, correlatively, the right to set the conditions of a licence in consideration for use of the IPR and as a reward for the innovative contribution contained therein. These exclusive rights are recognized in all patent laws as well as in the TRIPS agreement. Relying on the EC Treaty rule on abuse of a dominant position (Article 82 EC), the European Court of Justice (hereafter, the "ECJ") indicated in Magill and IMS that in certain exceptional circumstances IPR holders may be forced to grant a licence to other firms. The European Commission (hereafter, the "Commission") relied on this line of case law to mandate Microsoft in its March 2004 Decision to license its interoperability information to its competitors on the downstream market for work-group servers. This decision of the Commission was recently confirmed by the Court of First Instance of the EC (hereafter, the "CFI"), hence signaling that the first prerogative attached to the holding of an IPR, i.e. the right to exclude, could be subject to limitations under EC competition rules. More recently, the European Commission has taken an interest in the level of royalties that are charged by IP holders. The Commission adopted in February 2008 a decision imposing a fine of 899 million euros on Microsoft for non-compliance with its obligation to licence its downstream competitors under its March 2004 Decision. This decision required Microsoft to licence its interoperability information on reasonable and non-discriminatory terms. This aspect of the decision effectively placed limits on the second prerogative attached to the possession of an IPR, i.e. the right to set the conditions attached to the granting of a licence. The bone of contention between the Commission and Microsoft related to the royalties Microsoft wanted to charge its competitors for the licence in question. The Commission rejected Microsoft's initial demand of a royalty rate of 3.87% of a licensee's product revenues for a patent licence and of 2.98% for a licence giving access to the secret interoperability information. Under the pressure of periodic penalty payments for non-compliance, Microsoft eventually agreed to provide a licence giving access to the interoperability information for a flat fee of 10,000 euros and an optional worldwide patent licence for a reduced royalty rate of 0.4% of licensees' product revenues.

Yet, Microsoft has not been the only high-technology firm targeted by Commission investigations. In August 2007, the European Commission sent a Statement of Objections to Rambus on the ground that it infringed Article 82 EC by claiming unreasonable royalties for the licensing of certain patents for "Dynamic Random Access Memory" chips (DRAMs) subsequent to a so-called "patent ambush". In October 2007, the European Commission also decided to open formal antitrust proceedings against Qualcomm following complaints lodged by Ericsson, Nokia, Texas Instruments, Broadcom, NEC and Panasonic, alleging that Qualcomm's licensing terms and conditions are not Fair, Reasonable and Non-Discriminatory ("FRAND") and, therefore, may breach EC competition rules. These last cases are particularly important as they are linked to the way in which firms seek to fund their research and development ("R&D") efforts and, in particular, to the funding of innovation through technology licensing. In the last two decades, the reliance upon "licensing" strategies as a source of revenue for IPR holders has seen a dramatic increase. Put simply, in return for an adequate remuneration (typically a royalty, but there may be other forms of consideration), innovators (licensors) grant to other firms (licensees) the right to use their proprietary technology to manufacture products for sale in downstream markets. IPR licensing strategies are not only pursued by organizations without manufacturing capabilities (e.g., university research centers). IPR holders active in downstream product markets (hereafter, "vertically-integrated firms") may be licensing their technologies to reap additional profits from their R&D expenditures, but also to obtain access to other firms' technologies through cross-licensing agreements.

Licensing agreements are widely seen as pro-competitive. They typically benefit both licensors and licensees. The licensee gains access to new technologies, which it can use to improve its manufacturing operations or embed in its products to increase their functionalities. The licensor accrues revenues from his initial R&D expenditures that can be invested in the development of new technologies, which will in turn lead to additional revenues, hence creating a virtuous circle of innovation. Licensing agreements are generally heavily negotiated between licensors and licensees, which in the vast majority of the cases reach mutually satisfactory agreements. Yet, tensions may arise between licensors and licensees over the terms of their IPR licensing deals. Such tensions are particularly likely to arise when licensing agreements have the potential to be worth hundreds of millions of Euros and small variations in terms and conditions can be financially significant for both parties. Against this background, the objective of this paper is not to offer a comprehensive discussion of the complex relationship between IPR and competition law or even of the application of competition rules to licensing arrangements. Instead, it seeks to address what seems to be a growing reliance on competition rules to control the level of royalties IPR owners are entitled to charge their licensees. In order to keep the discussion brief, this paper's focus will be relatively narrow. First, this paper focuses on the application of EC competition rules, and in particular Article 82 EC, to IPR licensing agreements. Cases decided or investigations launched under Section 2 of the Sherman Act or other US antitrust law provisions are not reviewed. Second, this paper focuses on competition law issues arising from the licensing of IPR that are essential to an industry standard.

This paper is divided into five parts. Following this introduction, Part II briefly explains the importance of standardization and the so-called FRAND regime, which applies to licensing agreements covering patents that are essential to a given industry standard. Then, Part III addresses the issues of market definition and the assessment of dominance in high-technology industries, which raise a number of complex issues that need to be considered carefully. Part IV analyses various licensing practices that may allegedly amount to abuses of a dominant position with a specific focus on price discrimination and what EC law refers to as "excessive" pricing. Finally, Part V contains a brief conclusion in which it is argued that technology markets are particularly complex and competition rules must thus be applied cautiously in such sectors as the risks of false positives are high and the impact of such risks on innovation can be large. Thus, in the absence of exclusionary practices - either at the upstream or downstream levels - competition law has little or no role to play when it comes to assessing the level of royalties agreed between licensors and licensees.